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The Peninsula

Highlighted Trend: Household Debt in South Korea

Published October 23, 2012
Category: South Korea

By Seongjin James Ahn

Recently, South Korean music artist PSY projected himself into international fame with “Gangnam Style”, a song and music video that went viral online and parodies the opulent lifestyles of Seoul’s upper class – and of those who try to imitate it.  While both humorous and entertaining, PSY’s song ultimately points to a real issue and a key vulnerability in the South Korea’s domestic economy: household debt. In July of 2012 household debt in Korea reached 155 percent of disposable income, a rate that is alarmingly high in comparison to other OECD nations and dangerously unsustainable.

In light of today’s struggling global economy, Koreans have been feeling the pinch due to decreased revenues and incomes from slow exports, and poor asset value growth particularly in real estate.  While these issues, among others, undoubtedly exacerbate the level of household debt in Korea, the fundamental problem is that Koreans are taking on more credit than they earn.  Credit card spending has been on the rise, risky loans have been distributed by non-banking financial institutions, and general consumer spending patterns have changed in recent years.

A Widening Gap, Declining Savings

According to data from the Bank of Korea, credit to households nearly doubled over the last ten years from $402 billion to $789 billion between 2002 and 2011, respectively.  While this fact by itself is not necessarily a cause for concern, it is a serious issue when compared against a) how much disposable income has increased relative to credit expansion, and b) how much Koreans are saving.

Since 2002 disposable income in Korea has indeed increased, but the amount of debt taken on by households has grown at a significantly higher rate.  In 2002, the discrepancy between total disposable income and total credit to households was about $50 billion, but by 2011 the gap quadrupled to about $206 billion.  The “Household Debt” dashboard visually illustrates the widening gap between disposable income and the amount of credit taken on by households over the last ten years.

Furthermore, Koreans have been saving less each year over the past eight years.  Since 2004, there has been a noticeable decline in the ratio of individual savings to disposable income.  This proportion dropped from about 14 percent in 2004 to about 9 percent in 2010.  Again, when taken alone this fact could be taken as a positive sign that indicates increased levels of consumption (ultimately contributing to overall economic growth); however, in light of the onerous rate of household debt in Korea, it could instead be a cause for concern indicating a decreasing ability to pay down existing debt.

The Price of Plastic and Risky Loans

Credit card usage in South Korea reveals something interesting about consumer spending and household debt.  Credit cards have obvious risks associated with them (i.e. high interest rates, late payments, defaults, etc.) and their increasingly widespread use is a contributing factor to the growing level of household debt.

According to data from the Bank of Korea, about 88 million sheets of cards were issued in 2007, while in 2011 the number of cards issued increased to 122 million.  But credit cards are not just being issued more frequently in Korea; they are also being used more often.  In fact, the Korea Times recently reported that credit card use in Korea is substantially higher than in other countries known for credit card use.  For instance, in 2010 card payments in the United States and the United Kingdom comprised only 15.5 and 8.1 percent of GDP, respectively, whereas in Korea it was 41.4 percent of GDP.

Credit card companies in Korea have thus earned striking profits in recent years. This year between January and June, the seven issuers of major credit cards in Korea earned a combined profit of about ₩ 1.41 trillion.  This figure more than doubles the profits earned during the same period last year in 2011, which was ₩ 633.8 billion.  Moreover, the total projected annual profits for 2012 is ₩ 2.5 trillion, which is one trillion more than the previous year.  Samsung and Shinhan Bank credit cards lead the pack thus far in profits with ₩ 690 billion and ₩ 432 billion, respectively.

Recently, non-banking financial institutions in Korea have also been criticized for issuing loans to vulnerable households; loans which a traditional bank would not have normally issued due to the levels of risk involved and have the potential to compound the problem of household debt.

Although such practices make credit card companies and non-banking financial institutions look bad, they are not entirely to blame for the high levels of debt in Korea.  A breakdown of domestic consumption over the last several years and months reveals that consumers share in the responsibility.

Click here for the full analysis.

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Shifting Trends in Domestic Consumption

So what are Koreans more spending on?  An analysis of consumption data shows that over the last ten years, a general trend is that the domestic economy is shifting towards goods or services associated with relatively higher costs, including health, education, and transportation (automobiles.)

Consumption of transportation, for example, increased by one percentage point as a ratio of total domestic consumption between 2005 and 2011, which is a difference of about $22.9 billion between the two years.  According to an index by the Bank of Korea, automobile manufacturing grew substantially between those years in comparison to other industries in manufacturing, reflecting the increased demand for autos in Korea.  Furthermore, a report by the Economist Intelligence Unit analyzed how the automobile industry was ripe for growth.  Not only were incomes rising in Korea, but there was ample space for the industry’s growth in comparison to the automobile industries of other economies.  For instance, in 2005 the United States had an estimated 800 automobiles per one thousand people, and Japan had 400 autos per thousand people.  However, in the same year Korea only had about 219 autos per thousand individuals.  Given this room for growth, and in light of growth in individual wealth and the expansion of credit, the automobile industry in Korea expanded.

Changes in domestic consumption in recent months have also been caused some unanticipated costs.  For instance, this past summer – amidst the height of household debt – Korea was hit by three typhoons (i.e. Bolaven, Tembin, and Sanba) causing households and businesses to spend unexpectedly on repairing damages and bearing the cost of income lost due to power outages.  The country also experienced weeks of high temperatures causing electricity consumption to run high.  An on-year comparison between August of 2011 and 2012 reveals that sales of electricity increased by 39.9 billion kilowatt hours, with the share of consumption by households surging by 12.5 percent.

Reining in the Debt

Fully aware that the level of household debt in Korea is unsustainable, authorities in Korea have committed to reining it in.  For one thing, a new “mobile payment” technology has been developed in order to decrease credit card use in Korea.  Depending on how widespread it will be used, this could be a significant step in the direction of lowering individual credit card debt since, unlike credit cards, payments will be made directly from debit accounts thus precluding the possibility of late payments and accrual of interest, while still accommodating for the ease of making payments provided by credit cards.

In order to alleviate household debt, several banks in Korea have also committed to lowering credit card transaction fees for small and medium sized enterprises, as well as providing free financial consulting services to low-middle income brackets.  Additionally, in an effort to curb the growth of debt in Korea some banks will introduce debt control programs and offer various new options for individuals to pay back their loans.

Furthermore, measures have been taken to improve the lending practices of non-banking financial institutions so as to prevent loans from being issued to vulnerable households.  The structure of mortgages may also accommodate for less volatile interest rates.  For more on government policies aimed at reducing household debt, refer to the following links: Government Policies for 2012; IMF Article IV Summary.

Ultimately, household debt is an important issue which will require close monitoring.  With presidential elections coming up in Korea, Koreans should pay close attention to the policies proposed by each candidate to reverse the trend of snowballing household debt which is making the domestic economy vulnerable.

Seongjin James Ahn is a Visiting Fellow with the Korea Economic Institute. The views expressed here are his own. 

Photos from强小杰‘s photostream on flickr Creative Commons.

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